American bond guru Bill Gross calls it “the new normal.” Bank of Canada Governor Mark Carney warns of “unusual uncertainty.” CIBC World Markets chief economist Avery Shenfeld labels it simply the “Great Disappointment.” Whatever you call the times we’re living in, it’s pretty obvious they ain’t great.
In every city, town and village across Canada, across the U.S., across Europe, it’s slowly sinking in: the party is over, at least for a while. The U.S. housing market catastrophe and the subsequent global stock market meltdown may be largely behind us, but in their wake we’ve been left with an unpleasantly persistent aftermath: sluggish growth, high unemployment rates, soaring personal and government debt, teetering house prices, and a dampened investment environment.
Add it all up—and throw in the fact that we’ve already done pretty much everything we can to stimulate our ailing global economies—and it really does look like we’re entering a new age of austerity. Some economists are saying that today’s sluggish real (inflation adjusted) gross domestic product (GDP) growth rate of about 2% a year could even become the new “cruising speed” for the Canadian economy—a big comedown from the 3% annual growth we’ve typically seen in the past. And let’s not even get started on the disastrous “double dip” scenarios sketched out by the economic bears.
In this environment, many of the assumptions of the past—house prices will always rise, interest rates will always fall, there’s a better job just around the corner—can no longer be counted on. That doesn’t mean you should load up on ammo and head for the hills. It just means acting a bit more defensively when it comes to your finances, at least for a while.
So what exactly should you be doing to survive—even thrive—in this age of austerity? Read on and we’ll take you through each of the specific threats on the horizon, and how you can protect yourself against each one. We’ll look at how to prosper in the new job market, what to do if you’re buying a house, how to invest your money defensively, and how you can adjust your retirement plans to stay on track. In the end, you’ll see that despite the challenging times, with a bit of belt-tightening, you can still keep your dreams within reach.
Threat # 1: No new jobs
Gone are the days when jobs were plentiful and employers focused on attracting and retaining talent. While the total number of people employed in Canada has recovered to where it was before the recession, much of the recovery has consisted of part-time work and service sector jobs. Unemployment has remained stubbornly high at about 8%, and more Canadians are finding themselves jobless for long periods.
The current situation is hard on many of us, but it’s worst for those trying to get into the job market for the first time. “It’s like the classic saying, you want me to have experience but you won’t hire me, so how do I get experience?” asks Brodie Metcalfe, 24, who graduated last spring from the University of Victoria with a B.A. in the humanities. He’s looking for work in the field of advocacy and community development, but he’s not having much luck. “Most of the organizations that normally would be hiring are not doing so because the government funding cuts have been pretty drastic.”
Those who already have jobs are having an easier time, but they’re still finding fewer opportunities to get ahead. Promotions are scarce and there aren’t many opportunities to jump to greener pastures, so workers are tending to stay put. Many human resources experts had thought the generation of employees now in their 20s, 30s and 40s were inveterate job-hoppers by nature, but now they’re seeing the whole market freeze up. “A lot of people are surprised,” says Claude Balthazard of the Ontario-based Human Resources Professionals Association. “They used to think of it as a generational thing—this is how this generation is—now they’re realizing that the economy was shaping those attitudes.”
Few economists see a big improvement in the coming years. “Economy-wide job creation is unlikely to be rapid enough to put a meaningful dent in the average unemployment rate,” wrote TD Bank economists Derek Burleton and Shahrzad Mobasher Fard in a recent commentary. They see unemployment continuing to hover at about 8% through 2011, before edging down to 7.5% by the end of 2012. Wage growth is expected to stay low at 2% or less for the next few years, except in a few of the more robust sectors.
How to protect yourself
More than ever before, education is the armour you need to survive in the current market. Craig Riddell, professor of economics at the University of British Columbia, says research has found that getting an education yields a real (after inflation) annual return on the money invested of 8% to 10% per year of schooling, even after accounting for the wages you didn’t earn while you were in school. That means the real return on a four year degree is something like 35% to 40% per year. You can expect a good educational payoff whether you go to university, community college or acquire a skilled trade, he says, although university tends to pay off better than college. And if those financial advantages aren’t enough, Riddell says research has also found that higher education tends to yield better health, longer life and higher levels of life satisfaction.
If you’re a young person like Metcalfe struggling to start your career, there are several things you can do to improve your chances. In some fields, short-term contract positions or even volunteer jobs can provide a foot in the door. Metcalfe worked last summer on contract for two months in his field, and it enhanced his qualifications—albeit not sufficiently to land a permanent job yet. So like many other young people, he’s employing a proven strategy for recent grads in tough times: he’s considering jobs that are farther afield as a next-best alternative. “I’m starting in my area of interest, but then I’ll start moving into other fields with which I’m somewhat familiar,” he says.
If you’re an older worker with a job, but you feel like you’re spinning your wheels, consider enhancing your professional skills by working on a professional qualification or degree on the side. It also pays to focus on opportunities that might exist within your existing firm. Many employers are reluctant to hire new staff right now, so you might be able to grab an inside opportunity that normally would have been posted for outside applicants. Barbara Moses, a career expert and author, says if you get the chance, you might also consider a lateral move within your company to broaden your skills—such as moving from marketing manager to communications manager. That won’t provide immediate advancement, but there’s a good chance it will improve your long-term potential and pay off down the road.
If you’re in the later stages of your career, you’re likely caught between realizing your early retirement dreams and staying in your job a bit longer for safety. If you are truly weary of working, you may be able to move up your retirement date by scaling back your retirement plans. Other workers prefer not to quit work entirely, but to scale back to part-time work to bring in some income and stay engaged.
In some fields, you might find temporary or contract positions for short-term or part-time jobs, which tend to be relatively common in troubled times because employers are reluctant to commit to permanent hiring. If you’re an older worker with specialized skills who has worked for one employer for a long time, “adjusting your expectations is a key,” says Riddell of UBC. “On average, such workers are unemployed much longer after losing their jobs than younger workers, and a huge part of that is their expectations are unrealistically high given the labour market they now face.”
Threat #2: Home prices dip
Previous generations did well by riding the decade-long surge in home prices, but most economists agree that’s all over now. Prices in most large Canadian cities are very high relative to incomes and a slow-growth economy is unlikely to produce the rising incomes necessary to fuel a continuing boom. Economists don’t know whether prices will fall a little, a lot, or stay about the same, but no one sees significant increases in the foreseeable future.
“It’s always been ‘Buy a house. It’s a good investment,’” says Patricia Gibson, who would like to settle down with her husband Tony in pricey Vancouver (we’ve changed the Gibsons’ names and some details to protect their privacy). “I know that’s how it was for my parents and how they viewed it. But I don’t see that anymore, because Vancouver prices are ludicrous. You pay $800,000 for a shack.”
Many Canadians are borrowing every penny they can to get into the market, but if you stretch to buy a house with a long amortization now, you might find yourself weighed down for years, even if prices stay steady. That’s because your income isn’t as likely to grow quickly going forward, so you may not be able to make extra payments. Plus, while huge mortgages with long amortizations are easy to carry at today’s exceptionally low interest rates, those interest rates could easily rise in the future. “If you take a 35-year amortization and you’re making minimum payments and your salary isn’t going up fast, you’re going to haul that anchor for your whole working lifetime,” says Malcolm Hamilton, actuary and partner with Mercer Human Resource Consulting.
How to protect yourself
Interest rates are enticingly low and your bank will happily lend you absurdly large sums, so it’s up to you to show restraint. “The bank was willing to throw $800,000 at us—I started laughing at them,” says Patricia. No less an authority than Bank of Canada Governor Mark Carney has been travelling the country telling Canadians to resist the temptation to load up on low-interest debt. “This cannot continue,” he told an audience in Windsor, Ont., in late September. He hinted that one possible scenario is that house prices could tumble, leaving you holding the bag with a monster mortgage. “While asset prices can rise or fall, debt endures,” he said pointedly.
If you must buy right now, buy a place you can really afford. Patricia and Tony are both in their late 30s and want children, so they say it’s likely they’ll buy within the next 10 months, despite the crazy Vancouver market. “Tick-tock, tick-tock, that’s my biological clock,” says Patricia. But they’ve put off thoughts of a dream home until the economy improves. “We don’t need the granite counter tops for now. We just need a structurally sound home we can pay off in a reasonable amount of time.” They have their sights set on paying perhaps $600,000 for a 1,600-sq-ft townhouse. They expect to cover 20% to 30% of the cost with a down payment, and they want a 20- to 25-year amortization. In an era when housing may no longer be an investment, but just a place to live, the Gibsons realize they need to be careful about how much debt they take on and how long they take to pay it off.
Threat #3: Freedom 67
Borrowing has kept the world economy afloat during the recent recession, but governments have quickly accumulated debt to the point where it’s becoming a problem. Most international comparisons find that Canada’s combined federal and provincial debt is low to middling compared to other developed countries, so we’re not as badly off as some. Still, Canadian provincial and federal governments have been busy concocting plans to cut their deficits (which only slows the rate of debt growth) and ultimately start to pay down some of the debt itself.
It’s not going to be easy. They don’t want to do it too abruptly, for fear of knocking down the fragile recovery. But they don’t want to do it too slowly, either, for fear that the debt problem spirals from bad to worse. “The situations that governments are in today are astonishingly bad,” says economist William Robson, president of the C.D. Howe Institute. “It’s not like anything we’ve seen before. Looking around the world, Canada may be one of the less ugly contestants in this very unpleasant beauty contest. But at some point someone is going to say, you know what, they’re all ugly!”
Compounding the problem is the rising government cost of looking after aging baby boomers. According to a recent study by Robert Brown, professor of actuarial science at the University of Waterloo, governmental costs that can be attributed to an aging population will really start to bite around 2016, and they will keep increasing until they peak around 2031.
Some expect that the Canadian government will eventually be forced to raise the official retirement age from 65 to 67, or even higher. Other countries, like the U.S. and Germany, are already raising the official retirement date to 67 through a gradual phase-in program. For governments, getting people to work longer has the two-fold advantage of generating more taxes while reducing the cost of government benefits, says Brown. With a phase-in program, raising the official retirement age may have little or no impact on those already retired or about to retire, but it could have a big impact on the more distant retirements of Canadians who are still in their middle and younger years.
How to protect yourself
There’s no easy way to deal with this risk, other than to be prepared. Like those in Europe and the U.S., Canadians will simply need to get used to the idea of getting a little less help from the government while paying more in taxes. Canadians who are middle-aged or younger will likely at some point see the official retirement age push past age 65. That would mean Canada Pension Plan and Old Age Security payments might start a year or two later. It would be harder to retire in your early 60s, like most Canadians do today, because it is expensive to bridge the costs of fully supporting yourself until the government programs for seniors kick in.
On the up side, of course, is the fact that today’s young Canadians will probably live longer than those on the cusp of retirement right now. That means they may actually enjoy just as many retirement years as earlier generations did—they’ll just start a little later. The key is to consider this possible freedom-67 scenario when you’re doing your retirement planning so you’re not caught off guard. You may have to save a bit more, or you might have to work a little longer. But as long as your health is good, working longer could actually make things easier. After all, you’ll be able to spread your retirement saving over more working years, and hopefully you’ll still enjoy a couple of decades of stress-free living in your golden years.
Threat #4: Sluggish markets
In the heady days before the crash, Heather and Mark Mitchell, a couple living in a small town just outside of Calgary, were right on the verge of their dream retirement. They had almost all of their money in stocks, and their adviser had even persuaded them to borrow an extra $200,000 to invest in stocks to goose their hoped-for returns (and their adviser’s commissions along the way).
The crash was a horrible, unexpected shock. Their retirement portfolio, once valued at $850,000, was decimated. Today Heather is 54 and Mark is 60 (we’ve changed their names and some details to protect their privacy), and even after the subsequent partial recovery, their holdings are down almost 40%, with a current value of $525,000. “We were naïve,” says a chastened and wiser Heather about investing so heavily in stocks. And as for borrowing to invest, “We were dumb and greedy, which is a diabolical combination.”
The crash reminded all investors how disastrous it can be to have almost all your nest egg in risky investments like stocks. Today, there is more of a focus on “return of capital, not return on capital,” a phrase coined by investment guru Mohamed El-Erian, co-chief investment officer of Pacific Investment Management Co. (PIMCO). Individual and institutional investors alike have gradually moved enormous sums from riskier investments like stocks into safer fixed-income investments like bonds and GICs. Bond funds have had record inflows of cash, and U.S. private-sector pension plans have cut their stock exposure from almost 70% in the mid-2000s, to only 45% this year.
Unfortunately, partly because everyone wants to be in safe investments, that means returns on fixed income investments have sagged. If you had your nest egg primarily in GICs or investment-grade bonds before the crash, you avoided the stock market meltdown and did well in the immediate aftermath. But now record-low interest rates will ensure minuscule income going forward. Because of dampened performance expectations for both fixed income and equities over the next few years, economist Don Drummond says investors should lower their expectations. You should expect a total rate of return of 4% to 7% a year (not adjusted for inflation) on a typical diversified portfolio over the coming years, he says, even though surveys show many investors still think they will get well over 8%.
How to protect yourself
Some say the fact that many types of investments fell in lock-step during the crash means that diversification doesn’t work, but that’s not true. Almost everyone suffered, but those with properly diversified portfolios suffered less. Going forward, the situation is uncertain, and it’s at times like this, when no one really knows which asset classes will outperform or lag, that diversification makes the most sense.
The best way to protect yourself from the unexpected is to set a long-term asset allocation that fits your time horizon and risk tolerance and stick with it. The classic starting point is to devote 40% to 60% of your entire portfolio to stocks, and the rest to fixed income investments. Consider increasing your fixed income exposure as you get older, so that you’re less likely to be sideswiped by a crash just as you close in on retirement. One approach is to set the percentage of your portfolio dedicated to fixed income equal to your age—so if you are 55, for instance, then you would put 55% of your portfolio in bonds and GICs. It also makes sense in your senior years to consider adding annuities to your portfolio between the ages of 65 and 75.
Within the fixed-income portion of your portfolio you should avoid investing heavily in long-term bonds. The current unusual situation in the markets has bid up bond prices and pushed down yields. Inflation is very low due to the troubled economy, and investors have been flocking to government bonds for safety. Many economists fear the current flood of monetary stimulus from central banks will eventually rouse more inflation. That in turn would cause central banks to increase interest rates, which could push down long-term bond prices dramatically. Having most of your fixed-income investments in relatively short-term bonds, real-return bonds, or laddered GICs will provide some insulation against these risks.
After considering all the rotten things that could happen over the next few years, you may be getting discouraged. Don’t be. It’s always a good idea to try to predict what threats could derail your financial plans—but at the same time, there’s no reason to throw away your dreams. Letting yourself get so depressed about the future that you give up altogether is worse than being a little too optimistic.
When we talked to the Gibsons and the Mitchells, we found that they were still relatively upbeat, despite a cautious outlook. They’ve learned a lot from the last few years, and they’re trying to focus on putting that knowledge to work—while remembering that they still have a lot to be grateful for.
The Gibsons could, for instance, be bitter about having to pay $600,000 for a relatively small townhouse, but instead they’re counting on what they have going for them—their combined incomes of $160,000 a year, the $190,000 they have in the bank, and Tony’s generous pension. They’re still determined to buy a home, have the kids they want, and yes, they plan to retire early as well—hopefully by age 60. To help accomplish all that, they have resolved to ramp up the amount they save. They’re now putting aside $1,500 a month instead of $1,000. They’ve also decided to start tracking where their spending goes and they hope that will help them identify further savings.
The Mitchells were hit even worse, losing almost 40% of their $850,000 nest egg right on the verge of retirement. Originally they had dreamed of retiring in 2008, buying a place on the ocean in B.C. and spending five or six months a year travelling the world. As a result of their massive investment losses, they have put off those early retirement plans, and now they don’t think they’ll ever be able to afford a place on the water.
Currently, Mark still has a good job working in administration at a Fort McMurray oil sands operation, which pays $90,000 a year, plus a bonus. Heather has years of experience as a human resources manager but is currently not working due to illness. They’ve decided that they will likely try to retire in 2012. At that point Mark will be 62 and Heather will be 56, and they expect to have built up more savings.
Despite the change of plans, they’re both philosophical about what their future will bring. “You take a re-evaluation of your life,” says Heather. “What are things that are most important to you? What are the things that are nice to have, but if you don’t have them you’ll still have a good life?”
They realize that their current nest egg of $525,000 is still bigger than the one most couples will have at their age and they’re confident that when they do retire, they’ll be comfortable. “We’ve had to think about what would be a quality retirement for us,” says Heather. “It does look different than it did before—but it’s still okay.”
You may need to make a few adjustments to your plans to prepare for this new age of austerity, but for most people, they needn’t be drastic. As the Gibsons realized, a little bit of extra saving each month goes a long way if you start well ahead of retirement and you are consistent. And as the Mitchells found, you can adapt to almost any situation more easily than you think, by adjusting your priorities and expectations.
Many of those adjustments are simply a return to the timeless personal finance basics that have worked wonders for generations: educate yourself, get a good job, save for the future, pay down your mortgage quickly, invest for the long run. If you have been following those principles all along, you might not have to change a thing. And when economic conditions improve—and they will—you could find that you’re far better off than you expected.
How to get ahead in the age of austerity
|THE OLD RULES||THE NEW RULES|
|Job-hop your way up the corporate ladder.||Look for job security and get educated while you wait for better times.|
|Pump up your net worth by investing in a home.||Buy a home when you need shelter – your home is just a place to live.|
|Stretch out to buy the most home you can.||Stay within your means and buy a home you can afford.|
|Max out your amortization period.||Pay off your mortgage as fast as you can – before interest rates start to rise.|
|Grow your net worth by investing in real estate and stocks.||Grow your net worth by saving more.|
|Expect lots of help from the government, particularly in your senior years.||Expect a bit less from the government. Plan on living longer, staying healthier and retiring later.|
|To maximize gains, invest most of your portfolio in “stocks for the long-run”.||Balance your portfolio between stocks and fixed invome. Focus on return of capital, not return on capital.|
|Retire as soon as you can afford it.||Ease into retirement gradually.|